Prime Minister Ehud Olmert has rejected the Finance Ministry's two alternatives for cutting the 2009 budget, which are, slashing from defense or welfare. He has ordered the treasury chiefs to come up with alternatives in order to preserve the budget framework, while saving the sacred cows.

In any case Olmert agrees that government spending must not exceed this year's by more than 1.7%, which is the ceiling under law.

One possibility is that untapped budget reserves could be used, say sources. Another possibility is to trim do resources allocated for the national priority plan in outlying areas as presented last week by finance minister Roni Bar-On, or cutting into budgeting earmarked for emergency purposes.

Olmert has been holding consultations on the 2009 budget all week, including with central bank governor Stanley Fischer, who is currently abroad. Fischer agrees that the budget increase must not exceed 1.7%, lest Israel's sovereign credit rating be downgraded.

Olmert met yesterday with Bar-On ahead of a cabinet meeting on the budget on Sunday. He ordered the minister to continue talking with the ministries, trying to reach accords on ways to redirect resources in order to avoid breaking the budget.

The PM is worried about timing, meanwhile. Commencing budget debates in October could result in a budget badly skewed towards special interests. "Any connection between the 2009 budget and coalition negotiations must be avoided," he said.

Yesterday the prime minister's bureau denied press reports that Olmert has already reached an agreement with Labor chairman Ehud Barak to increase the budget by an additional 2.2%. Labor Party sources deny it. The sources say Olmert isn't confirming the agreement with Barak, in order to avoid confrontation with the treasury for the present.

Opposition leader Benjamin Netanyahu of Likud criticized the budget proposal at a special Knesset session held yesterday, during the summer recess. "As far as the economy is concerned, the government has failed," he said.

Netanyahu warned that economic crisis in Israel is looming. "We are on the brink of a big fall, the tsunami is on the way," he said. Economic trouble is not only bad for the people and the market: it is bad for the nation's security as well, he said. "Defense cannot be ensured without an economy, and we are nearing a situation where we will be asked to make choices that we would not be asked to make if we could maintain economic growth," he said.

Avishay Braverman of Labor, the chairman of the Knesset Finance Committee called yesterday to increase budget spending by 2.5%. The difference between the 1.7% proposed by the treasury, and 2.5% as demanded by Labor, would be about NIS 2 billion.